Paving the way for private pensions

As the pension debate gathers momentum, we seem to be making two basic assumptions: The first assumption being that the introduction of private pensions will alleviate the inherent problems of our public pension system; and the second assumption being that the introduction of private pensions will only succeed if contributions are made mandatory and rewarded through substantial tax incentives. In this article, we hope to dispel these assumptions and argue for the immediate introduction of voluntary second pillar pensions.

Our public pension system functions on the Pay as You Go model. This means that workers pay weekly social security contributions from which payments to all retirees are made on an ongoing basis. As our population ages, there will be less workers contributing to this system and more retirees claiming their share.

The likely result being that, as more of us retire, we will not receive an income commensurate to our lifestyle and our expectations. Indeed, this is gradually already becoming a reality for most of our pensioners. If we are to keep the Pay as You Go model, drastic and possibly unpopular changes will need to be made. These may include a rise of the retirement age and increases to the contributions paid by workers and their employers.

Private pensions will offer workers and their employers the opportunity to establish a separate savings pot to which they may contribute throughout their working life. Typically, one’s savings will be commensurate to one’s earnings and consequently, retirement income from a private pension should better meet one’s retirement income goals. In all probability, as the years roll on and our private pension pots grow, we will all place more faith in our private pension and become less dependent on our dwindling expectations of any retirement income from public pensions. Our attention should therefore focus on private pensions in their own right as an effective retirement planning option regardless of the broader public pension reform debate.

The second assumption that private pensions will only succeed if made mandatory and if accompanied by substantial tax incentives also needs due consideration. Experience in states where no tax incentives are offered on contributions to private pensions shows that individuals still rely on private pensions. Similarly, local experience shows that the take-up of insurance products paying out benefits on retirement has been consistent although these products have not benefitted from any notable tax incentives and are generally not offered as an employment package.

Similarly, we are confident that, even if private pensions are introduced without a comprehensive system of fiscal incentives they should be a successful tool for savers. Tax incentives may subsequently be bolted on to system at a later stage as economic conditions improve and the state’s public finances warrant such a decision. Likewise, if and when the time is ripe to do so, we may also contemplate rendering pillar two contributions mandatory.

Introducing private pensions in this manner initially will also spawn a local pension industry which is currently almost absent. Suppliers of private pension products and of support services will be given an opportunity to build their expertise and capacity in the field gradually, free from the pressures which a mandatory system imbued with tax advantages would demand of them.

As the industry matures it will be better placed to cope with the above structural developments of the private pension system as they are rolled out.

We see little reason to delay the introduction of private pensions any longer, certainly not because of concerns with the reform of the public pension system or because of concerns of a fiscal nature.

mbianchi@jmganado.com

• Dr Bianchi was assisted by Matthew Mizzi, a law student training with the law firm.

The author is partner of the Insurance & Pensions Team at Ganado & Associates, Advocates.